The tax gap

In a recent disclosure, the Chairman Federal Board of Revenue (FBR) admitted that tax gap of Pakistan is Rs 3,000 billion.

According to a press report, he said that this gap “is on annual basis and exists mainly in the shape of tax exemptions for powerful lobbies, massive tax evasions, and the inability of the machinery to collect due taxes”. The FBR Chairman was speaking at the Summer Camp of Lahore Tax Bar on July 22, 2022.

Quite strangely, it was not brought to the knowledge of public what to speak of taking input from the stakeholders and local tax experts that some study/analysis was undertaken to determine tax gap on the basis of recent facts and figures and size of burgeoning parallel economy.

The grand alliance government of Pakistan Democratic Movement (PDM) assumed power on April 9, 2022. It has been criticizing its predecessors for violating the principles of transparency, but itself violated all norms of good governance by commissioning such a vital study without any public knowledge.

Even the Lahore Tax Bar where FBR Chairman made this revelation did not agitate the issue. There was no reporting of the matter in the media till the above cited report was published that revealed the following:

“We have found that the total tax potential under jurisdiction of the federal government stands at Rs 9,000 billion out of which the FBR collected Rs 6,000 billion so the tax gap was assessed at Rs 3,000 billion on a per annum basis,” the chairman shared the outcome of tax analysis gap while addressing a Summer Camp 2022 arranged by Pakistan Tax Bar Association Friday night”.

The Chairman FBR further revealed that this tax gap analysis was conducted by hiring a consultant “on the directives of Prime Minister Shehbaz Sharif on eve of the budget-making exercise for 2022-23”.

It is strange that according to Chairman FBR his organisation was assigned “to conduct the first-ever formal study to assess the ‘tax gap’ keeping in view jurisdictions of the federal government under 1973 Constitution for the imposition of taxes” [under the existing constitutional arrangements, the general sales tax (GST) on goods is the domain of the federal government while GST on services is in the jurisdiction of the provinces.

Income tax on agriculture is in the domain of the provinces]. He has completely forgotten that in these columns, as elaborated below, FBR’s tax gap study with the help of the World Bank was cited many a time. It is also pertinent to mention that the actual tax potential of Pakistan is determined at Rs 12 trillion against his claim of Rs 9 trillion only and tax gap is over Rs 6 trillion and not Rs 3 trillion!

The above confirms beyond any doubt that before assigning the study to the Chairman FBR, the Prime Minister of Pakistan did not bother to consult his office where he has special initiative unit, Ministry of Finance and local experts that’s fully aware of it and could apprise him of the real tax gap prevailing in Pakistan.

What makes the situation more painful is the fact that the Chairman FBR, a seasoned and experienced officer having second stint at this post, could not recollect the failed tax reforms experiments under international lenders and donors and reports published on tax gap many years back.

In How to bridge huge tax gaps?, Business Recorder, April 15, 2011, Bridging the tax gap — I, Business Recorder, October 5, 2018 and Bridging the tax gap — II, Business Recorder, October 7, 2018, the earlier studies on tax gaps were cited. In Tapping the real tax potential [Business Recorder, March 24, 2017], the following was mentioned:

“Tax gap of a country is measured by the amount of tax that remains uncollected due to non-compliance with tax laws A study, ‘Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology’, jointly undertaken by the Federal Board of Revenue (FBR) and Andrew Young School of Policy Studies at Georgia State University, provides details of tax gaps by type of tax and describes the methodologies and data used for such estimates”.

“Pakistan’s tax revenue remains very low relative to comparator developing countries and the tax effort expected for the country’s level of development. This reflects narrow tax bases, overgenerous tax concessions and exemptions, weak and fragmented revenue administrations…” — Unlocking Pakistan’s revenue potential by Ms. Serhan Cevik, Country Report 16/2 (January 2016), IMF’.

The federal budget for fiscal year 2023 was presented on June 10, 2022 and all the above material was already available. Printed articles and papers by the IMF and the World Bank were ignored by the Prime Minster, once known as Khadim-e-Aala (Chief Servant), by FBR as well as by the Federal Finance Minister, Miftah Ismail.

It is worth mentioning that the fact of tax gap study was not made public. It was also not revealed how a consultant was hired in deviation of established rules of open bidding by the Ministry of Finance or FBR.

The International Monetary Fund (IMF) having close eye on the budget making process for revival of stalled programme also did not take cognizance of the matter. Our worthy Finance Minister held inconclusive negotiations with the IMF in Doha, Qatar, from May 18-25, 2020.

He also appears to have failed to mention that FBR was doing a “first-ever” (sic) formal study to assess the ‘tax gap’. If real potential is Rs 9 trillion as conceded by the Chairman FBR then why the target for the current fiscal year of FBR is fixed at only Rs 7.25 trillion? Why the government is forced to borrow more money when taxes to the extent of Rs 12 trillion can be collected. The Chairman FBR seems to have ignored the following facts that testify to the incontrovertible evidence that our tax potential is much higher than Rs. 9 trillion.

In Tax reforms: Agenda for Self-Sustainability, Management Accountant, Volume 31.2 [pp 36-38], March-April 2022], it was once again shown with facts and figures by one of us that the real tax potential, at the level of FBR alone is Rs 12.4 trillion, if not more.

Its working is available in Towards Flat, Low-rate, Broad and Predictable Taxes [PRIME Institute, Islamabad, December 2020] that was shockingly ignored by FBR in its latest tax gap analysis for which fee was paid to a consultant. Neither the analysis is yet made public nor the fee paid to the consultant hired is disclosed.

It is high time that FBR should make the tax gap analysis public on its website as required under Article 19A of the Constitution of Islamic Republic of Pakistan.

The public, especially taxpayers, have every right to know as to how this assignment was commissioned without seeking the best possible talent through open pubic bidding.

Secondly, how earlier studies and the recent article by one of us were ignored showing that 21 million potential individual taxpayers were not filing income tax returns and that collection in their case alone could be around Rs 6,400 billion.

At present, out of total registered companies, 53,900 are not filing income tax returns. Assuming average tax of Rs. 5 million per company, tax potential comes to Rs 269.5 billion. Collection of income tax by FBR in fiscal year 2021-22 was Rs 2,278 billion (companies, individuals, firms and association of persons). On this basis total income tax potential alone would not be less than Rs 8,400 billion.

Sales tax collection in fiscal year 2021-2022 is Rs 2,525 billion, whereas actual potential is not less than Rs 3,500 billion, as per own admission of FBR. Similarly, the potential of Customs Duty (using 3% rate on US$ 60 billion base could fetch Rs 360 billion). Federal Excise Duty (FED) even if kept at current position can fetch Rs 275 billion.

In view of the above, total tax potential at FBR level comes to Rs 12.4 trillion [Income Tax: Rs 8.3 trillion; Sales Tax: Rs 3.5 trillion; Customs Duty: Rs 360 billion and FED Rs 275 billion] and if we withdraw all exemptions/concessions and waivers as pointed out by FBR chairman a further amount of Rs 1.5 trillion can be collected.

According to a press report, during Doha parleys between Pakistan and the IMF, there was “disagreement on the next year’s revenue collection target. The IMF demanded to fix it at Rs 7.25 trillion while FBR showed different scenarios ranging from Rs 6.8 trillion to Rs 7 trillion”.

It is strange that neither IMF nor FBR bothered to determine the real tax potential as discussed above. Fixation of tax target at Rs 7.25 trillion is highly low. It should have been Rs 12 trillion, if not more in the light of above studies and facts. The onus is now on FBR to post its tax gap analysis on website so that further comments can be made.

(Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’)

Copyright Business Recorder, 2022